CareTrust REIT, Inc. (NYSE:CTRE) Q3 2023 Earnings Call Transcript

CareTrust REIT, Inc. (NYSE:CTRE) Q3 2023 Earnings Call Transcript November 10, 2023

Operator: Good day, everyone, and welcome to the CareTrust REIT Announces Third Quarter 2023 Operating Results. Today’s call is being recorded and all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Lauren Beale, Senior Vice President and Controller. Please go ahead.

Lauren Beale: Thank you, and welcome to CareTrust REIT’s third quarter 2023 earnings call. Participants should be aware that this call is being recorded and listeners are advised that any forward-looking statements made on today’s call are based on management’s current expectations, assumptions and beliefs about CareTrust’s business and the environment in which it operates. These statements may include projections regarding future financial performance, dividends, acquisitions, investments, returns, financings and other matters and may or may not reference other matters affecting the company’s business or the businesses of its tenants, including factors that are beyond their control, such as natural disasters, pandemics such as COVID-19 and governmental actions.

The company’s statements today and its business generally are subject to risks and uncertainties that could cause actual results to materially differ from those expressed or implied herein. Listeners should not place undue reliance on forward-looking statements and are encouraged to review CareTrust’s SEC filings for a more complete discussion of factors that could impact results as well as any financial or other statistical information required by SEC Regulation G. Except as required by law, CareTrust REIT and its affiliates do not undertake to publicly update or revise any forward-looking statements where changes arise as a result of new information, future events, changing circumstances or for any other reason. During the call, the company will reference non-GAAP metrics such as EBITDA, FFO and FAD or FAD and normalized EBITDA, FFO and FAD.

When viewed together with GAAP results, the company believes these measures can provide a more complete understanding of its business, but cautions that they should not be relied upon to the exclusion of GAAP reports. In addition, certain operator coverage and financial information that we discuss is based on data provided by our operators that has not been independently verified by CareTrust. Yesterday, CareTrust filed its Form 10-Q and accompanying press release and its quarterly financial supplement, each of which can be accessed on the Investor Relations section of CareTrust’s website at www.caretrustreit.com. A replay of this call will also be available on the website for a limited period. On the call this morning are Dave Sedgwick, President and Chief Executive Officer; Bill Wagner, Chief Financial Officer; and James Callister, Chief Investment Officer.

I’ll now turn the call over to Dave Sedgwick, CareTrust REIT’s President and CEO. Dave?

Dave Sedgwick: Well, good morning, everyone, and thank you for joining us. As we round third base on this year, we are pleased to report progress on several fronts. Not only have we made a significant return to external growth by investing $280 million year-to-date, but also we have set the table for 2024 and 2025, with an active pipeline and a ton of dry powder. We have financed that $280 million of investments by selling $420 million worth of equity of our ATM. The excess proceeds were used to completely pay down the $600 million line of credit, resulting in a net debt to EBITDA of 2.5 times at quarter end. We are willing to take some modest dilution in the short run to be positioned to take full advantage of the favorable investment environment we are in today and expect to be in for the foreseeable future.

I will touch on our investment activity in the quarter and how we are thinking about next year. I’ll also touch on the portfolio and the regulatory environment, and James and Bill will take it from there. First, investments. After a significant return to external growth in Q2, the team has continued to drive forward with its foot on the gas. Since Q2, we have invested another $79 million with a blended estimated stabilized yield of 10.2%. Investment activity since Q2 consists of two loans for just over $19 million at a blended rate of 9.6%. The loans we make are done strategically to borrowers and operators, who we believe will lead us to true acquisition opportunities in the future. That was certainly the case again with these two loans. Investments since Q2 also included two acquisitions, consisting of three skilled nursing facilities in California.

We added one skilled nursing facility at a yield of 9.7%. The second deal was for two high-performing skilled nursing facilities with a lease in place operated by Covenant Care. You will notice in the supplemental that with this acquisition, Covenant Care’s property level EBITDAR coverage pops to 1.43 times. The leases in place initially yield just under 6%, but in 2027, the leases provide for a rent reset. Assuming current performance is maintained, our yield at the time of the reset is projected to be just under 11%. Now turning to the portfolio. You will see in the supplemental, lease coverage slightly improved overall. Let me chat about a couple of individual operators. Notably, and as I mentioned a second ago, Covenant Care EBITDAR coverage has popped up to 1.43x with the acquisition of two facilities with a very well covering lease in place.

Additionally, the same-store Covenant Care properties continued its trailing 12-month coverage improvement for the third quarter in a row. Eduro’s lease coverage has been on a downward trend the last couple of quarters. We are working with them on a solution for a couple of their non-core facilities that we agree should be in different hands. We have a great relationship with Eduro and are working closely with them to minimize any material impact to rent. Lastly, as of a few minutes ago, we are under contract to sell the 11 skilled nursing facilities in the Midwest that we classified as held for sale last quarter. We hope to close on that sale before our next earnings call. Finally, on the regulatory front, one quick comment. We add our voice to the thousands of others in our industry that have called for significant changes to the proposed minimum staffing mandate from the Federal Government.

The proposed rule requires 24-hour RN coverage at 0.55 RN hours per patient day and 2.45 hours per patient day for certified nurses aids with no mention of LPN hours nor adjustment for acuity. Even with the delayed in staged implementation schedules, the industry is unified in its efforts to work with CMS to modify the proposed rule to be in a form that the industry can work with. We’re hopeful that CMS will pay attention to the feedback they’ve solicited and modify the rule. Now James will give you more color on the pipeline, but I’ll just say this. The investment landscape is very favorable for us as we head into 2024. As I said before, the table is set for the next couple of years. We have a favorable cost of capital that allows for accretive investments.

We have a balance sheet that provides enormous flexibility. We can do roughly $500 million of investments and still end up below our stated range of four to five times debt to EBITDA. And we have a macro environment that has sidelined some of our historic high leverage competitors, and we do not expect the banks to come roaring back with cheap debt anytime soon. So with that, James will talk to our recent activity and pipeline. James?

James Callister: Thanks, Dave. Let me just briefly provide an update on the current investment environment and add some color on our current pipeline. With respect to seniors housing, most of the proposed transactions that we see continue to involve facilities that are in some stage of operational distress, typically due to maturity day risk or variable interest rate loans, including risks related to the expiration of interest rate cap agreements. As a result, the bid-ask gap in seniors housing remains wide. We nevertheless continue to look for attractive senior housing deals where a triple-net lease structure might given current rates in the constrained lending market, be an attractive alternative to traditional debt financing for those operators who are looking to grow and add scale to their operations.

We continue to see robust deal flow in skilled nursing transactions. Pricing that is based on stabilized cash flows and coverage is still very rare. With that said, we’re also seeing a decrease from the last couple of years in transactions involving portfolios that are experiencing negative cash flows and heavy losses. A combination of factors, including Medicaid rate increases, healthier labor markets, census recovery and lower agency staffing levels that facilitated some measure of recovery in many portfolios. As a result, most skilled nursing assets being marketed currently reflect recent performance landing at breakeven or better, but still a fair distance from stabilization. As facilities show muted improvement in performance, sellers bringing buildings to market range from institutional owners and REITs continuing to dispose of non-core and non-strategic assets, the regional owner operators or mom-and-pops, who are fatigue and are looking to capitalize on a return to positive cash flow by selling and exiting the space.

Sellers’ pricing expectations and correspondingly brokers’ guidance appear to be gradually softening to take into account performance results to fall short of stabilization, but the pace of price softening is still lower than anticipated. We expect to see a continued narrowing of the bid-ask in skilled nursing, given the continuing high interest rates, lenders enhanced credit and recourse requirements, maturity date risk and a smaller buyer pool. As purchase prices slowly continue to settle, lease yields will also likely continue their slight push up towards and in some cases, beyond 10% with attractive basis levels better able to support a higher-yielding rent stream. Given opportunistic market dynamics, we continue to look for occasions where our attractive cost of capital and our flexibility in sourcing and structuring transactions can be used to create additional acquisition and investment opportunities that are accretive to our operators.

We will continue to execute on our acquisition strategy of disciplined growth with risk-adjusted returns consistent with health CareTrust has been built over the past several years. The pipeline today is around $175 million and mainly consists of singles and doubles. We are also continuing to review a few larger portfolio opportunities that would not only strengthen existing tenant relationships, but would also allow us to further diversify our tenant base by commencing relationships with outstanding operators that we have been pivoting for some time. Please remember that when we quote our pipe, we only quote deals we are actively pursuing under our current underwriting standards. And then only if we have a reasonable level of confidence, that we can lock them up and close them in the relative near-term.

And with that, I’ll turn it over to Bill.

Bill Wagner: Thanks, James. For the quarter, normalized FFO increased 1.5% over the prior year quarter to $36.6 million, and normalized FAD increased by 2% to $38.8 million. On a per share basis, normalized FFO decreased $0.02 to $0.35 per share and normalized FAD decreased $0.02 to $0.37 per share. Rental income for the quarter was $51.2 million compared to $47.7 million in Q2. The increase of $3.5 million is due largely to the following items. First, we received approximately $2.5 million from new investments. Second, we received approximately $402,000 in CPI bumps. Third, tenant reimbursements, which are non-income and FFO producing, because they have a corresponding expense increased $775,000 to $2 million. Lastly, these positive items were offset by $272,000, which is mostly from properties that we have sold.

If you exclude the tenant reimbursements amount of $2 million, contractual cash rental revenue was $49.2 million for the quarter. Interest income was up $851,000 due to new loans of $1 million, slightly offset by $191,000, of lower money market interest. The quarterly interest income run rate on our Notes portfolio is approximately $4.5 million. Interest expense was up $710,000 from Q2, due to higher average borrowings during the quarter and higher rates. G&A expense increased $801,000 from Q2, mostly due to stock compensation return to the quarterly run rate of roughly $1.6 million, as I previously discussed on last quarter’s call. I expect that G&A expense for the year will be around $21.4 million. Cash collections for the quarter came in at 97.5% of contractual rent.

And in October, we collected 99.3%. Under our ATM program, through today, we have sold approximately 18.2 million shares at an average gross price of $19.90 for gross proceeds of approximately $362 million. We have approximately $60 million still outstanding on forward contracts that we have not settled. As a result, our liquidity remains extremely strong with approximately $36 million in cash on hand, our entire $600 million available under our revolver and the $60 million of future ATM proceeds. I expect we will settle these remaining contracts before year-end, depending on the timing of closing future investments. Leverage at an all-time low with a net debt to normalized EBITDA ratio of 2.5 times, which is well below our stated range of four to five times.

Our net debt to enterprise value was 16.8% as of quarter end, and we achieved a fixed charge coverage ratio of 4.5 times. We wouldn’t be surprised to see leverage tick further downward as we continue to fund our pipeline with equity, given where the total cost of debt is at today relative to our cost of equity. And with that, I’ll turn it back to Dave.

Dave Sedgwick: Great. Well, we hope our report has been helpful and happy now to take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Connor Siversky with Wells Fargo. …

Connor Siversky: Hi there. Thanks for the time. Question on the competitive environment for skilled nursing and senior housing assets. I mean, as of last week, one of the other players in the group expressed an interest in skilled nursing in particular. So, I’m wondering with this kind of new entrant in the space, we’re not a new entrant, but with this increased interest in the space. Does this affect the way you’re looking at pricing, whether or not you’re willing to move up the risk curve and maybe take on a relatively distressed operator in order to get a yield? I’m just curious how you’re thinking about these dynamics?

James Callister: Yes. This is James. There is a smaller buyer pool, I would say of the time of well carrying entering the space a little bit more. I’m not sure we compete for many of the same deals. But I think we look at each deal on its own and we look at the basis that can support and the operators that can get comfortable with the rent. And if we get an actionable deal that falls within kind of that criteria of what we’re looking for, we really get as aggressive as we can to tie it up and to get the deal done and to work with an operator to help us give the most aggressive or most — the highest bid we can and still feel good about the deal. So I think there’s definitely a little bit of increase in competition even though it’s a smaller buyer pool. But I wouldn’t say, it impacts, how we view what pricing, we feel we can be competitive at and have a successful run with that asset.

Connor Siversky: Okay. And then when we take 2024 into consideration, should we be expecting maybe two, three asset deals? Or are there some portfolios out there that can make a big dent at one time?

Dave Sedgwick: Well, Connor, historically, when we’ve had kind of our larger investment years, there’s always been kind of a chunkier deal in there. And so we’re always reviewing those. Those are smaller, lower probability of getting it done, but they’re certainly out there. And we expect those to continue to cross our desk into next year. But right now, the visibility that we have and the confidence that we have are more of the singles and doubles that you’re used to seeing us put together.

Connor Siversky: Okay. And then very quickly for Bill, it’s a great job with the balance sheet. It looks like the next slug of activity is pretty much prefunded. But you still have the cost of equity. There is still some ATM capacity out there. Should we just assume that any acquisitions for the next year go straight on to the revolver? Or could we still see some equity issuance to balance it out?

Bill Wagner: No. I think you can assume, as I said in my prepared remarks that we would continue to fund investments with equity given where the cost of debt is relative to our cost of equity right now.

Connor Siversky: Okay. Thanks for the time.

Operator: We’ll take our next question from Austin Wurschmidt with KeyBanc Capital Markets.

Austin Wurschmidt: Great. Good morning out there. You guys have mentioned that you really highlight and focus on deals that you have a reasonable confidence you can close. So I guess I’m just curious, what kind of the probability is that you’re able to get one of these across the finish line? And then can you also discuss about the yields on portfolio transactions relative to the singles and doubles in that $175 million pipeline you discussed?